Hedge Funds and Alpha masters

Knowledge@Wharton: Your book profiles 11 hedge fund managers at nine funds and the big trades they have made. Some win, some lose. It gives a good sense of how this industry operates and the kind of people who run it. You’re quite young, and you got into the industry very young. Can you tell us about that?

Maneet Ahuja: I started on Wall Street at Citigroup as an intern when I was 17 years old. It was just supposed to be a semester-long internship. If you go to school in the city, they have year-round positions for folks like me. After 10 months, the lady I was working for decided not to come back after maternity leave. That opened up an opportunity because I was able to juggle the work with school, and I found it really interesting and fascinating.

She discusses hedge fund and finance basics ..Leaving that discussion..

On HF criticisms:

Knowledge@Wharton: The industry certainly has its critics. All the alternate investment fields do, including the private equity funds and other forms of funds. One of the criticisms is that a lot of this is not creating anything or making anything. They’re not starting a new car company and hiring thousands of people to do it. They have their own employees. But a lot of these bets are sort of zero-sum games. With a credit default swap, you make money but somebody else loses it. For society as a whole, there’s not really any change. I’m wondering whether you have a sense of whether their role in society is a positive role or a negative one, as some critics claim. What is the social benefit of having it? What if the hedge fund industry were to disappear over night? Is there any reason why those of us who are not investors or employees would care?

Ahuja: Hedge funds really do a great [deal] to make the markets way more efficient, for the basic reason that they are willing to take risks that many other investors aren’t. They are very often the counterparties to banks on transactions that have become the norm on Wall Street. One could argue that Wall Street itself is a zero-sum game. Part of the problem with the financial crisis was that the banks were behaving like hedge funds when they had a fiduciary responsibility to their depositors and investors and clients to behave like a bank. When people and institutions and organizations do what the government wants them to do and has said is legal for them to do, then they are doing their part to provide efficiency to the markets.

On a second note, retail investors actually do benefit from hedge funds, even if they are not directly invested. Many of the managers profiled in my book had a big part in unveiling frauds. These short sellers like Jim Chanos, who was the one behind uncovering Enron, WorldCom and Tyco. Now they choose to speak to journalists when the time is appropriate, and we follow the normal protocols to be able to bring this fraud or these accounting frauds to the market. I know for a fact that they are trying to have a more active discussion to work with the SEC so that instead of being more reactive we can be more proactive.

There is an upside when an activist makes a big change in a company like JC Penney as Bill Ackman has committed to doing; all the improvements that are expected to come through in the next year or two make the shopping experience a better experience. The same can be said of Burger King and also companies like Target. There are some examples of successes and some examples of failures, of course. But, again, to go back to Bill Ackman, with General Growth Partners, he saw a more than 200% return on that investment, and I know for a fact and I had heard at investment conferences, that other retail investors got in on that trade right after it got back into the market, and they became millionaires just riding out what these hedge fund managers were doing on the long side.

Two trend she is seeing:

Knowledge@Wharton: In terms of strategy and investing styles, I know they vary radically. From your research, do you see any trends, and if so, is that just due to the opportunities that are available or is it due to an advance in their thinking?

Ahuja: There are two different things that I’m noticing right now. Number one, I’m seeing a lot of pension funds and endowments and [an interest] in the activist investing space — also sovereign wealth funds, but there’s less information publicly available about them because they choose to stay behind the curtain, so to speak….

Number two, I’m seeing that a lot of managers — at least the top 10% — are using credit default swaps, not just as a way to get higher returns, but to manage risk. I would predict that it should become a more standard practice across the industry.